Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark one)

 

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended September 30, 2018

 

OR

 

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to

 

Commission File Number 1-15839

 

 

ACTIVISION BLIZZARD, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-4803544

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

3100 Ocean Park Boulevard, Santa Monica, CA

 

90405

(Address of principal executive offices)

 

(Zip Code)

 

(310) 255-2000

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer x

 

Accelerated Filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

 

Emerging growth company o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.     o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

 

The number of shares of the registrant’s Common Stock outstanding at November 1, 2018 was 763,050,718.

 

 

 


Table of Contents

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

 

Table of Contents

 

 

Cautionary Statement

3

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets at September 30, 2018 and December 31, 2017

4

 

 

 

 

Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and September 30, 2017

5

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2018 and September 30, 2017

6

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and September 30, 2017

7

 

 

 

 

Condensed Consolidated Statement of Changes in Shareholders’ Equity for the nine months ended September 30, 2018

8

 

 

 

 

Notes to Condensed Consolidated Financial Statements

9

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

41

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

71

 

 

 

Item 4.

Controls and Procedures

73

 

 

 

PART II.

OTHER INFORMATION

73

 

 

 

Item 1.

Legal Proceedings

73

 

 

 

Item 1A.

Risk Factors

74

 

 

 

Item 6.

Exhibits

74

 

 

 

EXHIBIT INDEX

75

 

 

 

SIGNATURE

76

 

 

 

CERTIFICATIONS

 

 

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CAUTIONARY STATEMENT

 

This Quarterly Report on Form 10-Q contains, or incorporates by reference, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements consist of any statement other than a recitation of historical facts and include, but are not limited to: (1) projections of revenues, expenses, income or loss, earnings or loss per share, cash flow, or other financial items; (2) statements of our plans and objectives, including those related to releases of products or services; (3) statements of future financial or operating performance, including the impact of tax items thereon; and (4) statements of assumptions underlying such statements. Activision Blizzard, Inc. generally uses words such as “outlook,” “forecast,” “will,” “could,” “should,” “would,” “to be,” “plan,” “plans,” “believes,” “may,” “might,” “expects,” “intends,” “intends as,” “anticipates,” “estimate,” “future,” “positioned,” “potential,” “project,” “remain,” “scheduled,” “set to,” “subject to,” “upcoming” and other similar expressions to help identify forward-looking statements. Forward-looking statements are subject to business and economic risks, reflect management’s current expectations, estimates and projections about our business, and are inherently uncertain and difficult to predict.

 

The company cautions that a number of important factors could cause Activision Blizzard, Inc.’s actual future results and other future circumstances to differ materially from those expressed in any forward-looking statements. Such factors include, but are not limited to: sales levels of Activision Blizzard, Inc.’s titles, products, and services; concentration of revenue among a small number of titles; Activision Blizzard, Inc.’s ability to predict consumer preferences, including interest in specific genres and modes and preferences among platforms; the continued growth in the scope and complexity of our business, including the diversion of management time and attention to issues relating to the operations of our newly acquired or started businesses and the potential impact of our expansion into new businesses on our existing businesses; the amount of our debt and the limitations imposed by the covenants in the agreements governing our debt; counterparty risks relating to customers, licensees, licensors, and manufacturers; maintenance of relationships with key personnel, customers, financing providers, licensees, licensors, manufacturers, vendors, and third-party developers, including the ability to attract, retain, and motivate key personnel and developers that can create high-quality titles, products, and services; changing business models within the video game industry, including digital delivery of content and the increased prevalence of free-to-play games; product delays or defects; competition, including from other forms of entertainment; rapid changes in technology and industry standards; possible declines in software pricing; product returns and price protection; the identification of suitable future acquisition opportunities and potential challenges associated with geographic expansion; the seasonal and cyclical nature of the interactive entertainment market; the outcome of current or future tax disputes; litigation risks and associated costs; protection of proprietary rights; potential data breaches and other cybersecurity risks; shifts in consumer spending trends; capital market risks; the impact of applicable laws, rules, and regulations, including changes in those laws, rules, and regulations; domestic and international economic, financial, and political conditions and policies; tax rates and foreign exchange rates; the impact of the current macroeconomic environment; and the other factors identified in “Risk Factors” included in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2017.

 

The forward-looking statements contained herein are based on information available to Activision Blizzard, Inc. as of the date of this filing and we assume no obligation to update any such forward-looking statements. Although these forward-looking statements are believed to be true when made, they may ultimately prove to be incorrect. These statements are not guarantees of our future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control and may cause actual results to differ materially from current expectations.

 

Activision Blizzard, Inc.’s names, abbreviations thereof, logos, and product and service designators are all either the registered or unregistered trademarks or trade names of Activision Blizzard, Inc. All other product or service names are the property of their respective owners. All dollar amounts referred to in, or contemplated by, this Quarterly Report on Form 10-Q refer to United States (“U.S.”) dollars, unless otherwise explicitly stated to the contrary.

 

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PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

(Amounts in millions, except share data)

 

 

 

At September 30,
2018

 

At December 31,
2017

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

  $

3,308

 

$

4,713

 

Accounts receivable, net of allowances of $119 and $279, at September 30, 2018 and December 31, 2017, respectively

 

641

 

918

 

Inventories, net

 

174

 

46

 

Software development

 

348

 

367

 

Other current assets

 

501

 

476

 

Total current assets

 

4,972

 

6,520

 

Software development

 

174

 

86

 

Property and equipment, net

 

281

 

294

 

Deferred income taxes, net

 

243

 

459

 

Other assets

 

454

 

440

 

Intangible assets, net

 

826

 

1,106

 

Goodwill

 

9,763

 

9,763

 

Total assets

 

  $

16,713

 

$

18,668

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

  $

312

 

$

323

 

Deferred revenues

 

1,017

 

1,929

 

Accrued expenses and other liabilities

 

1,053

 

1,411

 

Total current liabilities

 

2,382

 

3,663

 

Long-term debt, net

 

2,670

 

4,390

 

Deferred income taxes, net

 

11

 

21

 

Other liabilities

 

991

 

1,132

 

Total liabilities

 

6,054

 

9,206

 

Commitments and contingencies (Note 16)

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.000001 par value, 2,400,000,000 shares authorized, 1,191,665,508 and 1,186,181,666 shares issued at September 30, 2018 and December 31, 2017, respectively

 

 

 

Additional paid-in capital

 

10,928

 

10,747

 

Less: Treasury stock, at cost, 428,676,471 shares at September 30, 2018 and December 31, 2017

 

(5,563)

 

(5,563)

 

Retained earnings

 

5,907

 

4,916

 

Accumulated other comprehensive loss

 

(613)

 

(638)

 

Total shareholders’ equity

 

10,659

 

9,462

 

Total liabilities and shareholders’ equity

 

  $

16,713

 

$

18,668

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Amounts in millions, except per share data)

 

 

 

For the Three Months Ended
September 30,

 

For the Nine Months Ended
September 30,

 

 

 

2018

 

2017

 

2018

 

2017

 

Net revenues

 

 

 

 

 

 

 

 

 

Product sales

 

  $

263

 

  $

384

 

  $

1,447

 

  $

1,373

 

Subscription, licensing, and other revenues

 

1,249

 

1,234

 

3,672

 

3,601

 

Total net revenues (Note 2)

 

1,512

 

1,618

 

5,119

 

4,974

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

 

 

Cost of revenues—product sales:

 

 

 

 

 

 

 

 

 

Product costs

 

127

 

149

 

416

 

422

 

Software royalties, amortization, and intellectual property licenses

 

20

 

37

 

214

 

200

 

Cost of revenues—subscription, licensing, and other revenues:

 

 

 

 

 

 

 

 

 

Game operations and distribution costs

 

257

 

249

 

777

 

717

 

Software royalties, amortization, and intellectual property licenses

 

109

 

117

 

278

 

359

 

Product development

 

263

 

273

 

776

 

750

 

Sales and marketing

 

263

 

345

 

741

 

899

 

General and administrative

 

208

 

191

 

623

 

539

 

Total costs and expenses

 

1,247

 

1,361

 

3,825

 

3,886

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

265

 

257

 

1,294

 

1,088

 

Interest and other expense (income), net

 

13

 

37

 

67

 

109

 

Loss on extinguishment of debt

 

40

 

 

40

 

12

 

Income before income tax expense (benefit)

 

212

 

220

 

1,187

 

967

 

Income tax expense (benefit)

 

(48)

 

32

 

25

 

109

 

Net income

 

  $

260

 

  $

188

 

  $

1,162

 

  $

858

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic

 

  $

0.34

 

  $

0.25

 

  $

1.53

 

  $

1.14

 

Diluted

 

  $

0.34

 

  $

0.25

 

  $

1.51

 

  $

1.12

 

 

 

 

 

 

 

 

 

 

 

Weighted-average number of shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

763

 

755

 

761

 

753

 

Diluted

 

771

 

766

 

771

 

764

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Amounts in millions)

 

 

 

For the Three Months Ended
September 30,

 

For the Nine Months Ended
September 30,

 

 

 

2018

 

2017

 

2018

 

2017

 

Net income

 

  $

260

 

  $

188

 

  $

1,162

 

  $

858

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

3

 

9

 

(7)

 

36

 

Unrealized gains (losses) on forward contracts designated as hedges, net of tax

 

(11)

 

(8)

 

25

 

(45)

 

Unrealized gains (losses) on investments, net of tax

 

 

(3)

 

4

 

(4)

 

Total other comprehensive income (loss)

 

  $

(8)

 

  $

(2)

 

  $

22

 

  $

(13)

 

Comprehensive income

 

  $

252

 

  $

186

 

  $

1,184

 

  $

845

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Amounts in millions)

 

 

 

For the Nine Months Ended September 30,

 

 

 

2018

 

2017

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

  $

1,162

 

  $

858

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Deferred income taxes

 

175

 

(138)

 

Depreciation and amortization

 

385

 

670

 

Amortization of capitalized software development costs and intellectual property licenses (1)

 

238

 

202

 

Loss on extinguishment of debt (Note 10)

 

40

 

12

 

Amortization of debt discount and financing costs

 

5

 

10

 

Share-based compensation expense (2)

 

164

 

118

 

Other

 

15

 

24

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

290

 

(140)

 

Inventories

 

(127)

 

(50)

 

Software development and intellectual property licenses

 

(305)

 

(227)

 

Other assets

 

(15)

 

(70)

 

Deferred revenues

 

(710)

 

(320)

 

Accounts payable

 

(14)

 

78

 

Accrued expenses and other liabilities

 

(512)

 

28

 

Net cash provided by operating activities

 

791

 

1,055

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of available-for-sale investments

 

(59)

 

(80)

 

Capital expenditures

 

(97)

 

(86)

 

Other investing activities

 

(4)

 

3

 

Net cash used in investing activities

 

(160)

 

(163)

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock to employees

 

91

 

150

 

Tax payment related to net share settlements on restricted stock units

 

(85)

 

(44)

 

Dividends paid

 

(259)

 

(226)

 

Proceeds from debt issuances, net of discounts

 

 

3,741

 

Repayment of long-term debt

 

(1,740)

 

(4,251)

 

Premium payment for early redemption of note (Note 10)

 

(25)

 

 

Other financing activities

 

(2)

 

(10)

 

Net cash used in financing activities

 

(2,020)

 

(640)

 

Effect of foreign exchange rate changes on cash and cash equivalents

 

(15)

 

72

 

Net increase (decrease) in cash and cash equivalents and restricted cash

 

(1,404)

 

324

 

Cash and cash equivalents and restricted cash at beginning of period

 

4,720

 

3,262

 

Cash and cash equivalents and restricted cash at end of period

 

  $

3,316

 

  $

3,586

 

 

(1)               Excludes deferral and amortization of share-based compensation expense.

(2)               Includes the net effects of capitalization, deferral, and amortization of share-based compensation expense.

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Nine Months Ended September 30, 2018

(Unaudited)

(Amounts and shares in millions, except per share data)

 

 

 

Common Stock

 

Treasury Stock

 

Additional
Paid-In

 

Retained

 

Accumulated
Other
Comprehensive

 

Total
Shareholders’

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Earnings

 

Income (Loss)

 

Equity

 

Balance at December 31, 2017

 

1,186

 

  $

 

(429)

 

  $

(5,563)

 

  $

10,747

 

  $

4,916

 

  $

(638)

 

  $

9,462

 

Cumulative impact from adoption of new revenue accounting standard (Note 3)

 

 

 

 

 

 

88

 

3

 

91

 

Components of comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

1,162

 

 

1,162

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

22

 

22

 

Issuance of common stock pursuant to employee stock options

 

5

 

 

 

 

93

 

 

 

93

 

Issuance of common stock pursuant to restricted stock units

 

2

 

 

 

 

 

 

 

 

Restricted stock surrendered for employees’ tax liability

 

(1)

 

 

 

 

(86)

 

 

 

(86)

 

Share-based compensation expense related to employee stock options and restricted stock units

 

 

 

 

 

174

 

 

 

174

 

Dividends ($0.34 per common share)

 

 

 

 

 

 

(259)

 

 

(259)

 

Balance at September 30, 2018

 

1,192

 

  $

 

(429)

 

  $

(5,563)

 

  $

10,928

 

  $

5,907

 

  $

(613)

 

  $

10,659

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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ACTIVISION BLIZZARD, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.             Description of Business and Basis of Consolidation and Presentation

 

Activision Blizzard, Inc. is a leading global developer and publisher of interactive entertainment content and services. We develop and distribute content and services on video game consoles, personal computers (“PC”), and mobile devices. We also operate esports events and leagues and create film and television content based on our intellectual property. The terms “Activision Blizzard,” the “Company,” “we,” “us,” and “our” are used to refer collectively to Activision Blizzard, Inc. and its subsidiaries.

 

The Company was originally incorporated in California in 1979 and was reincorporated in Delaware in December 1992. In connection with the 2008 business combination by and among the Company (then known as Activision, Inc.), Vivendi S.A. (“Vivendi”), and Vivendi Games, Inc., then an indirect wholly-owned subsidiary of Vivendi, we were renamed Activision Blizzard, Inc.

 

The common stock of Activision Blizzard is traded on The Nasdaq Stock Market under the ticker symbol “ATVI.”

 

Our Segments

 

Based upon our organizational structure, we conduct our business through three reportable segments, as follows:

 

(i) Activision Publishing, Inc.

 

Activision Publishing, Inc. (“Activision”) is a leading global developer and publisher of interactive software products and entertainment content, particularly for the console platforms. Activision primarily delivers content through retail and digital channels, including full-game and in-game sales, as well as by licensing software to third-party or related-party companies that distribute Activision products. Activision develops, markets, and sells products based on our internally developed intellectual properties, as well as some licensed properties. We have also established a long-term alliance with Bungie to publish its game universe, Destiny.

 

Activision’s key product franchises include: Call of Duty®, a first-person shooter for the console and PC platforms; and Destiny, an online universe of first-person action gameplay (which we call a “shared-world shooter”) for the console and PC platforms.

 

(ii) Blizzard Entertainment, Inc.

 

Blizzard Entertainment, Inc. (“Blizzard”) is a leading global developer and publisher of interactive software products and entertainment content, particularly for the PC platform. Blizzard primarily delivers content through retail and digital channels, including subscriptions, full-game, and in-game sales, as well as by licensing software to third-party or related-party companies that distribute Blizzard products. Blizzard also maintains a proprietary online gaming service, Blizzard Battle.net®, which facilitates digital distribution of Blizzard content and selected Activision content, online social connectivity, and the creation of user-generated content. Blizzard also includes the activities of the Overwatch LeagueTM, the first major global professional esports league with city-based teams, and our Major League Gaming (“MLG”) business, which is responsible for various esports events and serves as a multi-platform network for Activision Blizzard esports content.

 

Blizzard’s key product franchises include: World of Warcraft®, a subscription-based massive multi-player online role-playing game for the PC platform; StarCraft®, a real-time strategy franchise for the PC platform; Diablo®, an action role-playing franchise for the PC and console platforms; Hearthstone®, an online collectible card franchise for the PC and mobile platforms; Heroes of the Storm®, a free-to-play team brawler for the PC platform; and Overwatch®, a team-based first-person shooter for the PC and console platforms.

 

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(iii) King Digital Entertainment

 

King Digital Entertainment (“King”) is a leading global developer and publisher of interactive entertainment content and services, particularly on mobile platforms, such as Google Inc.’s (“Google”) Android and Apple Inc.’s (“Apple”) iOS. King also distributes its content and services on the PC platform, primarily via Facebook. King’s games are free to play, however, players can acquire in-game items, either with virtual currency or directly using real currency.

 

King’s key product franchises, all of which are for the mobile and PC platforms, include: Candy Crush™, which features “match three” games; Farm Heroes™, which also features “match three” games; and Bubble Witch™, which features “bubble shooter” games.

 

Other

 

We also engage in other businesses that do not represent reportable segments, including:

 

·                  the Activision Blizzard Studios (“Studios”) business, which is devoted to creating original film and television content based on our library of globally recognized intellectual properties, and which, in September 2018, released the third season of the animated TV series SkylandersAcademy on Netflix; and

 

·                  the Activision Blizzard Distribution (“Distribution”) business, which consists of operations in Europe that provide warehousing, logistics, and sales distribution services to third-party publishers of interactive entertainment software, our own publishing operations, and manufacturers of interactive entertainment hardware.

 

Basis of Consolidation and Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) and accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim reporting. Accordingly, certain notes or other information that are normally required by U.S. GAAP have been condensed or omitted if they substantially duplicate the disclosures contained in our annual audited consolidated financial statements. The year-end condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. Accordingly, the unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for the fair statement of our financial position and results of operations in accordance with U.S. GAAP have been included in the accompanying unaudited condensed consolidated financial statements. Actual results could differ from these estimates and assumptions.

 

The accompanying condensed consolidated financial statements include the accounts and operations of the Company. All intercompany accounts and transactions have been eliminated. Certain reclassifications have been made to prior year amounts to conform to the current period presentation.

 

The Company considers events or transactions that occur after the balance sheet date, but before the financial statements are issued, to provide additional evidence relative to certain estimates or to identify matters that require additional disclosures.

 

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Supplemental Cash Flow Information

 

For the nine months ended September 30, 2018, the beginning and ending cash and cash equivalents and restricted cash reported within our condensed consolidated statement of cash flows include restricted cash of $7 million and $8 million, respectively. For the nine months ended September 30, 2017, the beginning and ending cash and cash equivalents and restricted cash reported within our condensed consolidated statement of cash flows included restricted cash of $17 million and $10 million, respectively.

 

2.             Summary of Significant Accounting Policies

 

During the nine months ended September 30, 2018, there were no significant changes to our accounting policies, except for our adoption of a new revenue accounting standard as discussed below. Refer to Note 2 contained in our Annual Report on Form 10-K for the year ended December 31, 2017 for a summary of our other significant accounting policies.

 

Adoption of Accounting Standards Codification 606: Revenue from Contracts with Customers

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance related to revenue recognition. The new standard replaces all current U.S. GAAP guidance on this topic, eliminating all industry-specific guidance and providing a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. On January 1, 2018, we adopted the new accounting standard and related amendments (collectively, the “new revenue accounting standard”). As a result, we have updated our significant accounting policy disclosure for revenue recognition herein. Refer to Note 3 for the impact of adoption on our condensed consolidated financial statements.

 

Revenue Recognition

 

We generate revenue primarily through the sale of our interactive entertainment content and services, principally for console, PC, and mobile devices, as well as through the licensing of our intellectual property. Our products span various genres, including first-person shooter, action/adventure, role-playing, strategy, and “match three,” among others. We primarily offer the following products and services:

 

·                  full games, which typically provide access to main game content, primarily for console or PC;

 

·                  downloadable content, which provides players with additional in-game content to purchase following the purchase of a full game;

 

·                  microtransactions, which typically provide relatively small pieces of additional in-game content or enhancements to gameplay; and

 

·                  subscriptions to players in our World of Warcraft franchise, which provide continual access to the game content.

 

When control of the promised products and services is transferred to our customers, we recognize revenue in the amount that reflects the consideration we expect to receive in exchange for these products and services.

 

We determine revenue recognition by:

 

·                  identifying the contract, or contracts, with a customer;

 

·                  identifying the performance obligations in the contract;

 

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·                  determining the transaction price;

 

·                  allocating the transaction price to performance obligations in the contract; and

 

·                  recognizing revenue when, or as, we satisfy performance obligations by transferring the promised goods or services.

 

Certain products are sold to customers with a “street date” (which is the earliest date these products may be sold by retailers). For these products, we recognize revenues on the later of the street date and the date the product is sold to our customer. For digital full-game downloads sold to customers, we recognize revenue when it is available for download or is activated for gameplay. Revenues are recorded net of taxes assessed by governmental authorities that are imposed at the time of the specific revenue-producing transaction between us and our customer, such as sales and value-added taxes.

 

Payment terms and conditions vary by contract type, although terms generally include a requirement of payment immediately upon purchase or within 30 to 90 days. In instances where the timing of revenue recognition differs from the timing of invoicing, we do not adjust the promised amount of consideration for the effects of a significant financing component when we expect, at contract inception, that the period between our transfer of a promised product or service to our customer and payment for that product or service will be one year or less.

 

Product Sales

 

Product sales consist of sales of our games, including physical products and digital full-game downloads. We recognize revenues from the sale of our products after both (1) control of the products has been transferred to our customers and (2) underlying performance obligations have been satisfied.

 

Revenues from product sales are recognized after deducting the estimated allowance for returns and price protection, which are accounted for as variable consideration when estimating the amount of revenue to recognize. Returns and price protection are estimated at contract inception and updated at the end of each reporting period as additional information becomes available.

 

Sales incentives and other consideration given by us to our customers, such as rebates and product placement fees, are considered adjustments of the transaction price of our products and are reflected as reductions to revenues. Sales incentives and other consideration that represent costs incurred by us for distinct goods or services received, such as the appearance of our products in a customer’s national circular ad, are recorded as “Sales and marketing” expense when the benefit from the sales incentive is separable from sales to the same customer and we can reasonably estimate the fair value of the good or service.

 

Products with Online Functionality

 

For our software products that include both offline functionality (i.e., do not require an Internet connection to access) and significant online functionality, such as titles for the Call of Duty franchise, we evaluate whether the license of our intellectual property and the online functionality are distinct and separable. This evaluation is performed for each software product or product add-on, including downloadable content. If we determine that our software products contain a license of intellectual property separate from the online functionality, we consider market conditions and other observable inputs to estimate the transaction price for the license, since we do not generally sell the software license on a standalone basis. These products may be sold in a bundle with other products and services, which often results in the recognition of additional performance obligations.

 

We recognize revenue for arrangements that include both a license of intellectual property and separate online functionality when control of the license transfers to our customers for the portion of the transaction price allocable to the license and ratably over the estimated service period for the portion of the transaction price allocable to the online functionality. Similarly, we defer a portion of the cost of revenues on these arrangements and recognize the costs as the related revenues are recognized. The cost of revenues that are deferred include product costs, distribution costs, and software royalties, amortization, and intellectual property licenses, and excludes intangible asset amortization.

 

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Online Hosted Software Arrangements

 

For our online hosted software arrangements, such as titles for the Destiny, Overwatch, World of Warcraft, and Candy Crush franchises, substantially all gameplay and functionality are obtained through our continuous hosting of the game content for the player. Similar to our software products with online functionality, these arrangements may include other products and services, which often results in the recognition of additional performance obligations. Revenues related to online hosted software arrangements are generally recognized ratably over the estimated service period.

 

Subscription Arrangements

 

Subscription revenue arrangements are mostly derived from World of Warcraft, which is playable through Blizzard’s servers and is generally sold on a subscription-only basis. Revenues associated with the sales of subscriptions are deferred until the subscription service is activated by the consumer and are then recognized ratably over the subscription period as the performance obligations are satisfied.

 

Revenues attributable to the purchase of World of Warcraft software by our customers, including expansion packs, are classified as “Product sales,” whereas revenues attributable to subscriptions and other in-game revenues are classified as “Subscription, licensing, and other revenues.”

 

Licensing Revenues

 

In certain countries, we utilize third-party licensees to distribute and host our games in accordance with license agreements, for which the licensees typically pay us a fixed minimum guarantee and sales-based royalties. These arrangements typically include multiple performance obligations, such as an upfront license of intellectual property and rights to specified or unspecified future updates. Our estimate of the selling price is comprised of several factors including, but not limited to, prior selling prices, prices charged separately by other third-party vendors for similar service offerings, and a cost-plus-margin approach.  Based on the allocated transaction price, we recognize revenue associated with the minimum guarantee when we transfer control of the upfront license of intellectual property and/or upon transfer of control of future specified updates and ratably over the contractual term in which we provide the customer with unspecified future updates. Royalty payments in excess of the minimum guarantee are generally recognized when the licensed product is sold by the licensee.

 

Other Revenues

 

Other revenues primarily include revenues from downloadable content (e.g., multi-player content packs), microtransactions, and licensing of intellectual property other than software to third-parties.

 

Microtransaction revenues are derived from the sale of virtual currencies and goods to our players to enhance their gameplay experience. Proceeds from these sales of virtual currencies and goods are initially recorded in deferred revenue. Proceeds from the sales of virtual currencies are recognized as revenues when a player uses the virtual goods purchased with a virtual currency. Proceeds from the sales of virtual goods directly are similarly recognized as revenues when a player uses the virtual goods. We categorize our virtual goods as either “consumable” or “durable”. Consumable virtual goods represent goods that can be consumed by a specific player action; accordingly, we recognize revenues from the sale of consumable virtual goods as the goods are consumed and our performance obligation is satisfied. Durable virtual goods represent goods that are accessible to the player over an extended period of time; accordingly, we recognize revenues from the sale of durable virtual goods ratably over the period of time the goods are available to the player and our performance obligation is satisfied, which is generally the estimated service period.

 

Revenues from the licensing of intellectual property other than software to third parties primarily include the licensing of our (1) brand, logo, or franchise to customers and (2) media content. Fixed fee payments from customers for the license of our brand or franchise are generally recognized over the license term. Fixed fee payments from customers for the license of our media content are generally recognized when control has transferred to the customer, which may be upfront or over time.

 

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Significant Judgment around Revenue Arrangements with Multiple Deliverables

 

Our contracts with customers often include promises to transfer multiple products and services. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Certain of our games, such as titles in the Call of Duty franchise, may contain a license of our intellectual property to play the game offline, but also depend on a significant level of integration and interdependency with the online functionality. In these cases, significant judgment is required to determine whether this license of our intellectual property should be considered distinct and accounted for separately, or not distinct and accounted for together with the online functionality provided and recognized over time. Generally, for titles in which the software license is functional without the online functionality and a significant component of gameplay is available offline, we believe we have separate performance obligations for the license of the intellectual property and the online functionality.

 

Significant judgment is also required to determine the standalone selling price for each distinct performance obligation and to determine whether there is a discount that needs to be allocated based on the relative standalone selling price of the various products and services. To estimate the standalone selling price we consider market data, including our pricing strategies for the product being evaluated and other similar products we may offer, competitor pricing to the extent data is available, and costs to determine whether the estimated selling price yields an appropriate profit margin.

 

Estimated Service Period

 

We consider a variety of data points when determining the estimated service period for players of our games, including the weighted average number of days between players’ first and last days played online, the average total hours played, the average number of days in which player activity stabilizes, and the weighted-average number of days between players’ first purchase date and last date played online. We also consider known online trends, the service periods of our previously released games, and, to the extent publicly available, the service periods of our competitors’ games that are similar in nature to ours. We believe this provides a reasonable depiction of the transfer of services to our customers, as it is the best representation of the time period during which our customers play our games. Determining the estimated service period is subjective and requires management’s judgment. Future usage patterns may differ from historical usage patterns, and therefore the estimated service period may change in the future. The estimated service periods for players of our current games are generally less than 12 months.

 

Principal Agent Considerations

 

We evaluate sales of our products and content via third-party digital storefronts, such as Microsoft Corporation’s (“Microsoft”) Xbox Games Store, Sony Interactive Entertainment Inc.’s (“Sony”) PSN, the Apple App Store, and the Google Play Store, to determine whether revenues should be reported gross or net of fees retained by the storefront. Key indicators that we evaluate in determining gross versus net treatment include, but are not limited to, the following:

 

·      which party is primarily responsible for fulfilling the promise to provide the specified good or service; and

 

·      which party has discretion in establishing the price for the specified good or service.

 

Based on our evaluation of the above indicators, we report revenues on a gross basis for sales arrangements via the Apple App Store and the Google Play Store, and we report revenues on a net basis (i.e., net of fees retained by the digital storefront) for sales arrangements via Microsoft’s Xbox Games Store and Sony’s PSN.

 

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Contract Balances

 

We generally record a receivable related to revenue when we have an unconditional right to invoice and receive payment, and record deferred revenue when cash payments are received or due in advance of our performance, even if amounts are refundable.

 

The allowance for doubtful accounts reflects our best estimate of probable losses inherent in our accounts receivable balance. In estimating the allowance for doubtful accounts, we analyze the age of current outstanding account balances, historical bad debts, customer concentrations, customer creditworthiness, current economic trends, and changes in our customers’ payment terms and their economic condition, as well as whether we can obtain sufficient credit insurance. Any significant changes in any of these criteria would affect management’s estimates in establishing our allowance for doubtful accounts.

 

Deferred revenue is comprised primarily of unearned revenue related to the sale of products with online functionality or online hosted arrangements. We typically invoice, and collect payment for, these sales at the beginning of the contract period and recognize revenue ratably over the estimated service period. Deferred revenue also includes payments for: product sales pending delivery or activation; subscription revenues; licensing revenues with fixed minimum guarantees; and other revenues for which we have been paid in advance and earn the revenue when we transfer control of the product or service.

 

Refer to Note 9 for further information, including changes in deferred revenue during the period.

 

Assets Recognized from Costs to Obtain a Contract with a Customer

 

We apply the practical expedient to expense costs, as incurred, to obtain a contract with a customer when the amortization period would have been one year or less for certain similar contracts in which commissions are paid to internal personnel or third parties. We believe application of the practical expedient has a limited effect on the amount and timing of cost recognition. Total capitalized costs to obtain a contract were immaterial as of September 30, 2018.

 

Allowances for Returns and Price Protection

 

We closely monitor and analyze the historical performance of our various titles, the performance of products released by other publishers, market conditions, and the anticipated timing of other releases to assess future demand of current and upcoming titles. Initial volumes shipped upon title launch and subsequent reorders are evaluated with the goal of ensuring that quantities are sufficient to meet the demand from the retail markets, but at the same time are controlled to prevent excess inventory in the channel. We benchmark units to be shipped to our customers using historical and industry data.

 

We may permit product returns from, or grant price protection to, our customers under certain conditions. In general, price protection refers to the circumstances in which we elect to decrease, on a short- or longer-term basis, the wholesale price of a product by a certain amount and, when granted and applicable, allow customers a credit against amounts owed by such customers to us with respect to open and/or future invoices. The conditions our customers must meet to be granted the right to return products or receive price protection credits include, among other things, compliance with applicable trading and payment terms and consistent return of inventory and delivery of sell-through reports to us. We may also consider other factors, including achievement of sell-through performance targets in certain instances, the facilitation of slow-moving inventory, and other market factors.

 

Significant management judgments and estimates with respect to potential future product returns and price protection related to current period product revenues must be made and used when establishing the allowance for returns and price protection in any accounting period. We estimate the amount of future returns and price protection for current period product revenues utilizing historical experience and information regarding inventory levels and the demand and acceptance of our products by the end consumer, and record revenue for the transferred products in the amount of consideration to which we expect to be entitled to. The following factors are used to estimate the amount of future returns and price protection for a particular title: historical performance of titles in similar genres; historical performance of the hardware platform; historical performance of the franchise; console hardware life cycle; sales force and retail customer feedback; industry pricing; future pricing assumptions; weeks of on-hand retail channel inventory; absolute quantity of on-hand retail channel inventory; our warehouse on-hand inventory levels; the title’s recent sell-through history (if available); marketing trade programs; and the performance of competing titles. The relative importance of these factors varies among titles depending upon, among other things, genre, platform, seasonality, and sales strategy.

 

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Based upon historical experience, we believe that our estimates are reasonable. However, actual returns and price protection could vary materially from our allowance estimates due to a number of reasons, including, among others: a lack of consumer acceptance of a title, the release in the same period of a similarly themed title by a competitor, or technological obsolescence due to the emergence of new hardware platforms. There may be material differences in the amount and timing of our revenues for any period if factors or market conditions change or if matters resolve in a manner that is inconsistent with management’s assumptions utilized in determining the allowances for returns and price protection.

 

Shipping and Handling

 

Shipping and handling costs consist primarily of packaging and transportation charges incurred to move finished goods to customers. We recognize all shipping and handling costs as an expense in “Cost of revenues-product costs,” including those incurred when control of the product has already transferred to the customer.

 

3.             Recently Issued Accounting Pronouncements

 

Recently Adopted Accounting Pronouncements

 

Revenue Recognition

 

As noted in Note 2 above, we adopted the new revenue accounting standard effective January 1, 2018, utilizing the modified retrospective method. Additionally, we elected to apply the new revenue accounting standard only to contracts not completed as of the adoption date. For contracts that were modified before the period of adoption, we elected to reflect the aggregate effect of all modifications when (1) identifying the satisfied and unsatisfied performance obligations, (2) determining the transaction price, and (3) allocating the transaction price to the satisfied and unsatisfied performance obligations. We recognized the cumulative effect of initially applying the new revenue accounting standard as an adjustment to the opening

 

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balance of retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. The cumulative effect adjustment recorded to our retained earnings was $88 million (see our condensed consolidated statements of changes in shareholders’ equity) and included the impact from the following adjustments to our condensed consolidated balance sheet at January 1, 2018 (amounts in millions):

 

Condensed Consolidated Balance Sheet:

 

Balance at
December 31,
2017

 

Adjustments due
to adoption of
new revenue
accounting
standard

 

Balance at
January 1, 2018

 

Assets

 

 

 

 

 

 

 

Accounts receivable, net

 

  $

918

 

  $

3

 

  $

921

 

Software development

 

367

 

(20)

 

347

 

Other current assets

 

476

 

(35)

 

441

 

Deferred income taxes, net

 

459

 

(32)

 

427

 

Other assets

 

440

 

4

 

444

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

Deferred revenues

 

  $

1,929

 

  $

(194)

 

  $

1,735

 

Other liabilities

 

1,132

 

23

 

1,155

 

Shareholders’ equity

 

9,462

 

91

 

9,553

 

 

The most significant impacts of the new revenue accounting standard for us are:

 

·                  The accounting for our sales of our games with significant online functionality for which we do not have vendor-specific objective evidence (“VSOE”) for unspecified future updates and ongoing online services provided. Under the prior accounting standards, VSOE for undelivered elements was required. This requirement was eliminated under the new revenue accounting standard. Accordingly, we are required to recognize as revenue a portion of the sales price upon delivery of this software, as compared to recognizing the entire sales price ratably over an estimated service period as previously required. This difference in accounting primarily impacts revenues from our Call of Duty franchise, where approximately 20% of the sales price is now recognized as revenue upon delivery of the games to our customers. The amount of revenue recognized upon delivery of games to our customers is analyzed on a title-by-title basis and may change in the future. For example, we expect the entire sales price from our Call of Duty: Black Ops 4 release to be recognized ratably over an estimated service period, as the gameplay has an increased focus towards the online competitive and cooperative game modes with no single-player campaign mode. Many of our other franchises, such as Destiny, Overwatch, World of Warcraft, and Candy Crush, are online hosted arrangements, and the accounting for our sales of these games under the new standard is relatively unchanged; and

 

·                  The accounting for certain of our software licensing arrangements. While the impact of the new revenue accounting standard may differ on a contract-by-contract basis (as the actual revenue recognition treatment required under the standard will depend on contract-specific terms), the new revenue accounting standard generally results in earlier revenue recognition for these arrangements.

 

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Adoption of the new revenue accounting standard impacted our condensed consolidated statement of operations for the three and nine months ended September 30, 2018, and our condensed consolidated balance sheet as of September 30, 2018 as follows (in millions, except per share data):

 

 

 

For the Three Months Ended September 30, 2018

 

Condensed Consolidated Statement of Operations:

 

Under new
revenue
accounting
standard

 

Under old
revenue
accounting
standards

 

Increase
(decrease) due to
adoption of new
revenue
accounting
standard

 

Net revenues

 

 

 

 

 

 

 

Product sales

 

  $

263

 

  $

269

 

  $

(6)

 

Subscription, licensing, and other revenues

 

1,249

 

1,226

 

23

 

Total net revenues

 

1,512

 

1,495

 

17

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

Cost of revenues—product sales:

 

 

 

 

 

 

 

Product costs

 

127

 

126

 

1

 

Software royalties, amortization, and intellectual property licenses

 

20

 

24

 

(4)

 

Cost of revenues—subscription, licensing, and other revenues:

 

 

 

 

 

 

 

Game operations and distribution costs

 

257

 

257

 

 

Software royalties, amortization, and intellectual property licenses

 

109

 

109

 

 

Product development

 

263

 

263

 

 

Sales and marketing

 

263

 

263

 

 

General and administrative

 

208

 

208

 

 

Total costs and expenses

 

1,247

 

1,250

 

(3)

 

 

 

 

 

 

 

 

 

Operating income

 

265

 

245

 

20

 

Interest and other expense (income), net

 

13

 

13

 

 

Loss on extinguishment of debt

 

40

 

40

 

 

Income before income tax expense (benefit)

 

212

 

192

 

20

 

Income tax expense (benefit)

 

(48)

 

(57)

 

9

 

Net income

 

  $

260

 

  $

249

 

  $

11

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

Basic

 

  $

0.34

 

  $

0.33

 

  $

0.01

 

Diluted

 

  $

0.34

 

  $

0.32

 

  $

0.02

 

 

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For the Nine Months Ended September 30, 2018

 

Condensed Consolidated Statement of Operations:

 

Under new
revenue
accounting
standard

 

Under old
revenue
accounting
standards

 

Increase
(decrease) due to
adoption of new
revenue
accounting
standard

 

Net revenues

 

 

 

 

 

 

 

Product sales

 

  $

1,447

 

  $

1,593

 

  $

(146)

 

Subscription, licensing, and other revenues

 

3,672

 

3,645

 

27

 

Total net revenues

 

5,119

 

5,238

 

(119)

 

 

 

 

 

 

 

 

 

Costs and expenses

 

 

 

 

 

 

 

Cost of revenues—product sales:

 

 

 

 

 

 

 

Product costs

 

416

 

438

 

(22)

 

Software royalties, amortization, and intellectual property licenses

 

214

 

232

 

(18)

 

Cost of revenues—subscription, licensing, and other revenues:

 

 

 

 

 

 

 

Game operations and distribution costs

 

777

 

777

 

 

Software royalties, amortization, and intellectual property licenses

 

278

 

278

 

 

Product development

 

776

 

776

 

 

Sales and marketing

 

741

 

740

 

1

 

General and administrative

 

623

 

623

 

 

Total costs and expenses

 

3,825

 

3,864

 

(39)

 

 

 

 

 

 

 

 

 

Operating income

 

1,294

 

1,374

 

(80)

 

Interest and other expense (income), net

 

67

 

67

 

 

Loss on extinguishment of debt

 

40

 

40

 

 

Income before income tax expense

 

1,187

 

1,267

 

(80)

 

Income tax expense

 

25

 

41

 

(16)

 

Net income

 

  $

1,162

 

  $

1,226

 

  $

(64)

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

Basic

 

  $

1.53

 

  $

1.61

 

  $

(0.08)

 

Diluted

 

  $

1.51

 

  $

1.59

 

  $

(0.08)

 

 

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At September 30, 2018

 

Condensed Consolidated Balance Sheet:

 

Under new
revenue
accounting
standard

 

Under old
revenue
accounting
standards

 

Increase
(decrease) due to
adoption of new
revenue
accounting
standard

 

Assets

 

 

 

 

 

 

 

Accounts receivable, net

 

  $

641

 

  $

637

 

  $

4

 

Software development

 

348

 

350

 

(2)

 

Other current assets

 

501

 

519

 

(18)

 

Deferred income taxes, net

 

243

 

262

 

(19)

 

Other assets

 

454

 

469

 

(15)

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

Deferred revenues

 

  $

1,017

 

  $

1,077

 

  $

(60)

 

Accrued expenses and other liabilities

 

1,053

 

1,056

 

(3)

 

Other liabilities

 

991

 

1,005

 

(14)

 

Shareholders’ equity

 

10,659

 

10,632

 

27

 

 

Adoption of the new revenue accounting standard had no impact to net cash from or used in operating, investing, or financing activities in our condensed consolidated statement of cash flows.

 

Financial Instruments

 

In January 2016, the FASB issued new guidance related to the recognition and measurement of financial assets and financial liabilities. The new standard, among other things, generally requires companies to measure investments in other entities, except those accounted for under the equity method, at fair value and to recognize any changes in fair value in net income. The new standard also simplifies the impairment assessment of equity investments without readily determinable fair values. The new standard is effective for fiscal years beginning after December 15, 2017, and the guidance should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The guidance related to equity investments without readily determinable fair values (including disclosure requirements) is applied prospectively to equity investments that exist as of the date of adoption. We adopted the new standard during the first quarter of 2018 and it did not have a material impact on our condensed consolidated financial statements.

 

Statement of Cash Flows-Restricted Cash

 

In November 2016, the FASB issued new guidance related to the classification of restricted cash in the statement of cash flows. The new standard requires that a statement of cash flows explain any change during the period in total cash, cash equivalents, and restricted cash. Therefore, restricted cash will be included with “Cash and cash equivalents” when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The new standard is effective for fiscal years beginning after December 15, 2017, and should be applied retrospectively.

 

We adopted the new standard during the first quarter of 2018 and applied the standard retrospectively for all periods presented. The application of this new standard did not have a material impact on our condensed consolidated statements of cash flows for the nine months ended September 30, 2018 and 2017.

 

In our Annual Report on Form 10-K for the year ending December 31, 2018, there will be a significant impact to the consolidated statements of cash flows for 2016, as this period includes, as an investing activity, the $3.6 billion movement in restricted cash resulting from the transfer of cash into escrow at December 31, 2015 to facilitate the acquisition of King, and the subsequent release of that cash in 2016 to complete the acquisition. Under this new standard, the restricted cash balance will be included in the beginning and ending total cash, cash equivalents, and restricted cash balances and, hence, will not be included as an investing activity in the statement of cash flows.

 

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Derivatives and Hedging

 

In August 2017, the FASB issued new guidance related to the accounting for derivatives and hedging. The new guidance expands and refines hedge accounting for both financial and non-financial risk components, aligns the recognition and presentation of the effects of hedging instruments and hedged items in the financial statements, and includes certain targeted improvements to ease the application of current guidance related to the assessment of a hedge’s effectiveness. The new standard is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. We adopted the standard during the first quarter of 2018. The adoption of the standard did not have a material impact to our condensed consolidated financial statements.

 

Recent Accounting Pronouncements Not Yet Adopted

 

Leases

 

In February 2016, the FASB issued new guidance related to the accounting for leases. The new standard will replace all current U.S. GAAP guidance on this topic. The new standard, among other things, requires a lessee to classify a lease as either an operating or financing lease, and to recognize a lease liability and a right-of-use asset for its leases. Classification will be based on criteria that are largely similar to those applied in current lease accounting. The lease liability will be equal to the present value of lease payments. The asset will be based on the lease liability, subject to adjustment for initial direct costs, lease incentives received, and any prepaid lease payments. Operating leases will result in a straight-line expense pattern, while finance leases will result in a front-loaded expense pattern. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. When the new standard was initially issued, it was required to be adopted using a modified retrospective transition that required application of the new guidance at the beginning of the earliest comparative period presented, subject to certain transition practical expedients available to provide relief in connection with the adoption. In July 2018, the FASB issued guidance to provide for an optional adoption method that allows companies to use the effective date of the new lease standard as the initial date of application on transition, and therefore does not require prior periods to be restated.

 

Although we continue to evaluate the impact of this new accounting guidance on our financial statements, we expect it to have a significant impact on our consolidated balance sheet as a result of establishing lease liabilities and right-of-use assets for our operating leases. As part of our evaluation process, we have established a project implementation team that is evaluating our lease portfolio and system solutions, as well as identifying required process and policy changes, which include consideration of internal controls. We have made progress in gathering the necessary data elements for our lease population, have selected a system provider, and system configuration and implementation is underway. We do not plan to early adopt this new standard but do expect to elect and apply the available transition practical expedients, including the optional adoption method discussed above.

 

Goodwill

 

In January 2017, the FASB issued new guidance that eliminates Step 2 from the goodwill impairment test. Instead, if an entity forgoes a Step 0 test, an entity will be required to perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit, as determined in Step 1 from the goodwill impairment test, with its carrying amount and recognize an impairment charge, if any, for the amount by which the carrying amount exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to the reporting unit. The new standard is effective for fiscal years beginning after December 15, 2019, and should be applied prospectively. Early adoption is permitted. The effect of adoption should be reflected as of the beginning of the fiscal year of adoption. We are evaluating the impact, if any, of adopting this new accounting guidance on our consolidated financial statements.

 

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Cloud Computing Arrangements

 

In August 2018, the FASB issued new guidance related to a customer’s accounting for implementation costs incurred in a cloud computing arrangement (i.e. hosting arrangement) that is a service contract. The new guidance requires customers to capitalize implementation costs for these arrangements by applying the same criteria that is utilized for existing internal-use software guidance. The capitalized costs are required to be amortized over the associated term of the arrangement, generally on a straight-line basis, with amortization of these costs presented in the same financial statement line item as other costs associated with the arrangement. The new standard is effective for fiscal years beginning after December 15, 2019, and can be applied retrospectively or prospectively. Early adoption is permitted. We are evaluating the impact, if any, of adopting this new accounting guidance on our financial statements.

 

4.                                      Inventories, Net

 

Inventories, net, consist of the following (amounts in millions):

 

 

 

At September 30, 2018

 

At December 31, 2017

 

Finished goods

 

  $

161

 

  $

45

 

Purchased parts and components

 

13

 

1

 

Inventories, net

 

  $

174

 

  $

46

 

 

At September 30, 2018 and December 31, 2017, inventory reserves were $23 million and $36 million, respectively.

 

5.                                      Software Development and Intellectual Property Licenses

 

The following table summarizes the components of our capitalized software development costs (amounts in millions):

 

 

 

At September 30, 2018

 

At December 31, 2017

 

Internally-developed software costs

 

  $

356

 

  $

270

 

Payments made to third-party software developers

 

166

 

183

 

Total software development costs

 

  $

522

 

  $

453

 

 

As of both September 30, 2018 and December 31, 2017, capitalized intellectual property licenses were not material.

 

Amortization of capitalized software development costs and intellectual property licenses was as follows (amounts in millions):

 

 

 

For the Three Months Ended
September 30,

 

For the Nine Months Ended
September 30,

 

 

 

2018

 

2017

 

2018

 

2017

 

Amortization of capitalized software development costs and intellectual property licenses

 

  $

33

 

  $

34

 

  $

242

 

  $

206

 

 

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6.                                      Intangible Assets, Net

 

Intangible assets, net, consist of the following (amounts in millions):

 

 

 

At September 30, 2018

 

 

 

Estimated useful
lives

 

Gross carrying
amount

 

Accumulated
amortization

 

Net carrying
amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Internally-developed franchises

 

3 - 11 years

 

  $

1,154

 

  $

(987)

 

  $

167

 

Developed software

 

2 - 5 years

 

601

 

(413)

 

188

 

Customer base

 

2 years

 

617

 

(617)

 

 

Trade names

 

7 - 10 years

 

54

 

(21)

 

33

 

Other

 

1 - 15 years

 

19

 

(14)

 

5

 

Total definite-lived intangible assets

 

 

 

  $

2,445

 

  $

(2,052)

 

  $

393

 

 

 

 

 

 

 

 

 

 

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

 

 

 

 

386

 

Acquired trade names

 

Indefinite

 

 

 

 

 

47

 

Total indefinite-lived intangible assets

 

 

 

 

 

 

 

  $

433

 

Total intangible assets, net

 

 

 

 

 

 

 

  $

826

 

 

 

 

At December 31, 2017

 

 

 

Estimated useful
lives

 

Gross carrying
amount

 

Accumulated
amortization

 

Net carrying
amount

 

Acquired definite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Internally-developed franchises

 

3 - 11 years

 

  $

1,154

 

  $

(869)

 

  $

285

 

Developed software

 

2 - 5 years

 

601

 

(301)

 

300

 

Customer base

 

2 years

 

617

 

(573)

 

44

 

Trade names

 

7 - 10 years

 

54

 

(16)

 

38

 

Other

 

1 - 15 years

 

19

 

(13)

 

6

 

Total definite-lived intangible assets

 

 

 

  $

2,445

 

  $

(1,772)

 

  $

673

 

 

 

 

 

 

 

 

 

 

 

Acquired indefinite-lived intangible assets:

 

 

 

 

 

 

 

 

 

Activision trademark

 

Indefinite

 

 

 

 

 

386

 

Acquired trade names

 

Indefinite

 

 

 

 

 

47

 

Total indefinite-lived intangible assets

 

 

 

 

 

 

 

  $

433

 

Total intangible assets, net

 

 

 

 

 

 

 

  $

1,106

 

 

Amortization expense of our intangible assets was $84 million and $280 million for the three and nine months ended September 30, 2018, respectively. Amortization expense of our intangible assets was $188 million and $573 million for the three and nine months ended September 30, 2017, respectively.

 

At September 30, 2018, future amortization of definite-lived intangible assets is estimated as follows (amounts in millions):

 

2018 (remaining three months)

 

  $

91

 

2019

 

210

 

2020

 

69

 

2021

 

11

 

2022

 

7

 

Thereafter

 

5

 

Total

 

  $

393

 

 

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7.                                      Goodwill

 

The carrying amount of goodwill by reportable segment at September 30, 2018 and December 31, 2017 was as follows (amounts in millions):

 

 

 

Activision

 

Blizzard

 

King

 

Total

 

Goodwill

 

  $

6,898

 

  $

190

 

  $

2,675

 

  $

9,763

 

 

8.                                      Fair Value Measurements

 

The FASB literature regarding fair value measurements for certain assets and liabilities establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of “observable inputs” and minimize the use of “unobservable inputs.” The three levels of inputs used to measure fair value are as follows:

 

·      Level 1—Quoted prices in active markets for identical assets or liabilities;

 

·      Level 2—Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets or liabilities in active markets or other inputs that are observable or can be corroborated by observable market data; and

 

·      Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities, including certain pricing models, discounted cash flow methodologies, and similar techniques that use significant unobservable inputs.

 

Fair Value Measurements on a Recurring Basis

 

The table below segregates all of our financial assets and liabilities that are measured at fair value on a recurring basis into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date (amounts in millions):

 

 

 

 

 

Fair Value Measurements at
September 30, 2018 Using

 

 

 

 

 

As of
September 30,
2018

 

Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Balance Sheet Classification

 

Financial Assets:

 

 

 

 

 

 

 

 

 

 

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

  $

3,087

 

  $

3,087

 

  $

 

  $

 

Cash and cash equivalents

 

Foreign government treasury bills

 

 

35

 

 

35

 

 

 

 

 

Cash and cash equivalents

 

U.S. treasuries and government agency securities

 

 

116

 

 

116

 

 

 

 

 

Other current assets

 

Foreign currency forward contracts designated as hedges

 

 

11

 

 

 

 

11

 

 

 

Other current assets

 

Total recurring fair value measurements

 

  $

3,249

 

  $

3,238

 

  $

11

 

  $

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts not designated as hedges

 

  $

(5)

 

  $

 —

 

  $

(5)

 

  $

 

Accrued expenses and other liabilities

 

Foreign currency forward contracts designated as hedges

 

  $

(4)

 

  $

 —

 

  $

(4)

 

  $

 

Accrued expenses and other liabilities

 

 

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Fair Value Measurements at December 31, 2017
Using

 

 

 

 

 

As of
December 31,
2017

 

Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Balance Sheet Classification

 

Financial Assets:

 

 

 

 

 

 

 

 

 

 

 

Recurring fair value measurements:

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

  $

4,405

 

  $

4,405

 

  $

 

  $

 

Cash and cash equivalents

 

Foreign government treasury bills

 

39

 

39

 

 

 

Cash and cash equivalents

 

U.S. treasuries and government agency securities

 

55

 

55

 

 

 

Other current assets

 

Total recurring fair value measurements

 

  $

4,499

 

  $

4,499

 

  $

 

  $

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

Foreign currency forward contracts designated as hedges

 

  $

(5)

 

  $

 

  $

(5)

 

  $

 

Accrued expenses and other liabilities

 

 

Foreign Currency Forward Contracts

 

Foreign Currency Forward Contracts Designated as Hedges (“Cash Flow Hedges”)

 

The total gross notional amounts and fair values of our Cash Flow Hedges are as follows (amounts in millions):

 

 

 

As of September 30, 2018

 

As of December 31, 2017

 

 

 

Notional amount

 

Fair value gain (loss)

 

Notional amount

 

Fair value gain (loss)

 

Foreign Currency:

 

 

 

 

 

 

 

 

 

Buy USD, Sell Euro

 

  $

843

 

  $

7

 

  $

521

 

  $

(5)

 

 

At September 30, 2018, our Cash Flow Hedges have remaining maturities of 15 months or less. Additionally, $3 million of net realized but unrecognized gains are recorded within “Accumulated other comprehensive income (loss)” at September 30, 2018 for Cash Flow Hedges that had settled but were deferred and will be amortized into earnings, along with the associated hedged revenues. Such amounts will be reclassified into earnings within the next 12 months.

 

The amount of pre-tax net realized gains (losses) associated with our Cash Flow Hedges that were reclassified out of “Accumulated other comprehensive income (loss)” and into earnings was as follows (amounts in millions):

 

 

 

For the Three Months Ended
September 30,

 

For the Nine Months Ended
September 30,

 

 

 

 

 

2018

 

2017

 

2018

 

2017

 

Statement of Operations Classification

 

Cash Flow Hedges

 

  $

3

 

  $

(2)

 

  $

(11)

 

  $

7

 

Net revenues

 

 

Foreign Currency Forward Contracts Not Designated as Hedges

 

The total gross notional amounts and fair values of our foreign currency forward contracts not designated as hedges are as follows (amounts in millions):

 

 

 

As of September 30, 2018

 

As of December 31, 2017

 

 

 

Notional amount

 

Fair value gain (loss)

 

Notional amount

 

Fair value gain (loss)

 

Foreign Currency:

 

 

 

 

 

 

 

 

 

Buy Euro, Sell USD

 

  $

119

 

  $

(5)

 

  $

 

  $

 

 

For the three and nine months ended September 30, 2018 and 2017, pre-tax net gains associated with these forward contracts were recorded in “General and administrative expenses” and were not material.

 

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Fair Value Measurements on a Non-Recurring Basis

 

We measure the fair value of certain assets on a non-recurring basis, generally annually or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable.

 

For the three and nine months ended September 30, 2018 and 2017, there were no impairment charges related to assets that are measured on a non-recurring basis.

 

9.             Deferred revenues

 

We record deferred revenues when cash payments are received or due in advance of the fulfillment of our associated performance obligations. The opening balance of deferred revenues as of January 1, 2018 and the ending balance as of September 30, 2018 were $1.8 billion and $1.0 billion, respectively, including our current and non-current balances. For the nine months ended September 30, 2018, the additions to our deferred revenues balance were primarily due to cash payments received or due in advance of satisfying our performance obligations, while the reductions to our deferred revenues balance were primarily due to the recognition of revenues upon fulfillment of our performance obligations, both of which were in the ordinary course of business. During the nine months ended September 30, 2018, $1.6 billion of revenues were recognized that were included in the deferred revenues balance at the beginning of the period.

 

As of September 30, 2018, the aggregate amount of contracted revenues allocated to our unsatisfied performance obligations is $2.2 billion, which includes our deferred revenues balances and amounts to be invoiced and recognized as revenue in future periods. We expect to recognize a significant majority of this balance as revenue over the next 12 months, and the remainder thereafter. This balance does not include an estimate for variable consideration arising from sales-based royalty license revenue in excess of the contractual minimum guarantee.

 

10.          Debt

 

Credit Facilities

 

At December 31, 2017, we had outstanding term loans “A” of approximately $990 million (the “2017 TLA”) and $250 million available under a revolving credit facility pursuant to a credit agreement entered into on October 11, 2013 (as amended thereafter and from time to time, the “Credit Agreement”).

 

On August 24, 2018, using available cash on hand, we made a voluntary prepayment of $990 million to fully repay and extinguish the 2017 TLA. As a result, we wrote-off unamortized discount and financing costs of $7 million, which are included in “Loss on extinguishment of debt” in the condensed consolidated statement of operations. On August 24, 2018, we also entered into the Seventh Amendment (the “Amendment”) to the Credit Agreement. The Amendment, among other things: (1) provided for a new tranche of revolving credit commitments in an aggregate principal amount of $1.5 billion (the “New Revolver”), which replaced our prior revolving credit facility; (2) amended the Credit Agreement to remove mechanics related to the 2017 TLA, which, as noted above, was repaid in full prior to the effectiveness of the Amendment; and (3) eliminated or amended certain representations, warranties and covenants to reflect our current credit ratings.

 

The New Revolver is scheduled to mature on August 24, 2023. Borrowings under the New Revolver will bear interest, at the Company’s option, at either (1) a base rate equal to the highest of (i) the federal funds rate, plus 0.5%, (ii) the prime commercial lending rate of Bank of America, N.A. and (iii) the London Interbank Offered Rate (“LIBOR”) for an interest period of one month beginning on such day plus 1.00%, or (2) LIBOR, in each case, plus an applicable interest margin.  LIBOR will be subject to a floor of 0% and base rate will be subject to an effective floor of 1.00%.  The applicable interest margin for borrowings under the New Revolver will range from 0.875% to 1.375% for LIBOR borrowings and from 0% to 0.375% for base rate borrowings and will be determined by reference to a pricing grid based on the Company’s credit ratings.  To date, we have not drawn on the New Revolver.

 

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Under the Credit Agreement, we are subject to a financial covenant requiring the Company’s Consolidated Total Net Debt Ratio (as defined in the Credit Agreement) not to exceed 3.75:1.00 (or, at the Company’s option and for a limited period of time upon the consummation of a Qualifying Acquisition (as defined in the Credit Agreement), 4.25:1.00). The Credit Agreement contains covenants customary for transactions of this type for issuers with similar credit ratings, including those restricting liens, debt of non-guarantor subsidiaries and certain fundamental changes, in each case with exceptions, including exceptions for secured debt and debt of non-guarantor subsidiaries of the Company, in each case up to an amount not exceeding 7.5% of Total Assets (as defined in the Credit Agreement). We were in compliance with the terms of the Credit Agreement as of September 30, 2018.

 

Refer to Note 11 contained in our Annual Report on Form 10-K for the year ended December 31, 2017 for further details regarding the Credit Agreement, its key terms, and previous amendments made to it.

 

Unsecured Senior Notes

 

At December 31, 2017, we had the following unsecured senior notes outstanding:

 

·                  $750 million of 6.125% unsecured senior notes due September 2023 that we issued on September 19, 2013 (the “2023 Notes”), in a private offering made in accordance with Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”);

 

·                  $650 million of 2.3% unsecured senior notes due September 2021 (the “2021 Notes”) and $850 million of 3.4% unsecured senior notes due September 2026 (the “2026 Notes”) that we initially issued on September 19, 2016, in a private offering made in accordance with Rule 144A and Regulation S under the Securities Act, and subsequently exchanged for publicly registered notes in June 2017; and

 

·                  $400 million of 2.6% unsecured senior notes due June 2022 (the “2022 Notes”), $400 million of 3.4% unsecured senior notes due June 2027 (the “2027 Notes”), and $400 million of 4.5% unsecured senior notes due June 2047 (the “2047 Notes”, and together with the 2021 Notes, the 2022 Notes, the 2023 Notes, the 2026 Notes, and the 2027 Notes, the “Notes”), that we issued on May 26, 2017, in a public underwritten offering.

 

On July 17, 2018, we issued an irrevocable notice of redemption to the holders of all of our outstanding 2023 Notes. Accordingly, on August 16, 2018, using available cash on hand, we redeemed the 2023 Notes in full at a redemption price equal to 100% of the principal amount of the 2023 Notes plus a “make-whole” premium calculated as set forth in the indenture governing the 2023 Notes and accrued and unpaid interest to the redemption date. The redemption of the 2023 Notes resulted in a “Loss on extinguishment of debt” recorded in the condensed consolidated statement of operations of $33 million, comprised of premium payments of $25 million and a write-off of unamortized discount and deferred financing costs of $8 million. All other Notes referred to above remained outstanding as of September 30, 2018.

 

The Notes are general senior obligations of the Company and rank pari passu in right of payment to all of the Company’s existing and future senior indebtedness, including the New Revolver described above. The Notes are not secured and are effectively junior to any of the Company’s existing and future indebtedness that is secured to the extent of the value of the collateral securing such indebtedness. We were in compliance with the terms of the Notes as of September 30, 2018.

 

Interest is payable semi-annually in arrears on March 15 and September 15 of each year for the 2021 Notes, the 2023 Notes, and the 2026 Notes, and payable semi-annually in arrears on June 15 and December 15 of each year for the 2022 Notes, the 2027 Notes, and the 2047 Notes. Accrued interest payable is recorded within “Accrued expenses and other liabilities” in our condensed consolidated balance sheets. As of September 30, 2018 and December 31, 2017, we had accrued interest payable of $14 million and $28 million, respectively, related to the Notes.

 

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Refer to Note 11 contained in our Annual Report on Form 10-K for the year ended December 31, 2017 for further details regarding key terms under our indentures that govern the Notes.

 

Interest Expense and Financing Costs

 

Fees and discounts associated with the issuance of our debt instruments are recorded as debt discount, which reduces their respective carrying values, and are amortized over their respective terms. Amortization expense is recorded within “Interest and other expense (income), net” in our condensed consolidated statement of operations.

 

For the three and nine months ended September 30, 2018, interest expense was $32 million and $113 million, respectively, and amortization of the debt discount and deferred financing costs were $1 million and $5 million, respectively. For the three and nine months ended September 30, 2017, interest expense was $39 million and $110 million, respectively, and amortization of the debt discount and deferred financing costs were $2 million and $10 million, respectively.

 

A summary of our outstanding debt is as follows (amounts in millions):

 

 

 

At September 30, 2018

 

 

 

Gross Carrying
Amount

 

Unamortized
Discount and
Deferred Financing
Costs

 

Net Carrying
Amount

 

2021 Notes

 

  $

650

 

  $

(4)

 

  $

646

 

2022 Notes

 

400

 

(3)

 

397

 

2026 Notes

 

850

 

(8)

 

842

 

2027 Notes

 

400

 

(5)

 

395

 

2047 Notes

 

400

 

(10)

 

390

 

Total long-term debt

 

  $

2,700

 

  $

(30)

 

  $

2,670

 

 

 

 

At December 31, 2017

 

 

 

Gross Carrying
Amount

 

Unamortized
Discount and
Deferred Financing
Costs

 

Net Carrying
Amount

 

2017 TLA

 

  $

990

 

  $

(8)

 

  $

982

 

2021 Notes

 

650

 

(4)

 

646

 

2022 Notes

 

400

 

(4)

 

396

 

2023 Notes

 

750

 

(9)

 

741

 

2026 Notes

 

850

 

(9)

 

841

 

2027 Notes

 

400

 

(6)

 

394

 

2047 Notes

 

400

 

(10)

 

390

 

Total long-term debt

 

  $

4,440

 

  $

(50)

 

  $

4,390

 

 

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As of September 30, 2018, the scheduled maturities and contractual principal repayments of our debt for each of the five succeeding years and thereafter are as follows (amounts in millions):

 

For the year ending December 31,

 

 

 

2018 (remaining three months)

 

  $

 

2019

 

 

2020

 

 

2021

 

650

 

2022

 

400

 

Thereafter

 

1,650

 

Total

 

  $

2,700

 

 

On February 1, 2018, our Board of Directors authorized repayment of up to $1.8 billion of the company’s outstanding debt during 2018. As of September 30, 2018, we had utilized this entire authorization to repay our 2017 TLA and redeem our 2023 Notes, as described above.

 

Using Level 2 inputs (i.e., observable market prices in less-than-active markets) at September 30, 2018, the carrying values of the 2021 Notes and the 2022 Notes approximated their fair values, as the interest rates were similar to the current rates at which we could borrow funds over the selected interest periods. At September 30, 2018, based on Level 2 inputs, the fair values of the 2026 Notes, the 2027 Notes, and the 2047 Notes were $809 million, $379 million, and $380 million, respectively.

 

Using Level 2 inputs at December 31, 2017, with the exception of the 2023 Notes and the 2047 Notes, the carrying values of our debt instruments approximated their fair values. At December 31, 2017, based on Level 2 inputs, the fair values of the 2023 Notes and the 2047 Notes were $795 million and $421 million, respectively.

 

11.          Accumulated Other Comprehensive Income (Loss)

 

The components of accumulated other comprehensive income (loss) were as follows (amounts in millions):

 

 

 

For the Nine Months Ended September 30, 2018

 

 

 

Foreign currency
translation
adjustments

 

Unrealized gain
(loss) on forward
contracts

 

Unrealized gain
(loss) on available-
for-sale securities

 

Total

 

Balance at December 31, 2017

 

  $

(623)

 

  $

(15)

 

  $

 

  $

(638)

 

Cumulative impact from adoption of new revenue accounting standard

 

3

 

 

 

3

 

Other comprehensive income (loss) before reclassifications

 

(7)

 

14

 

4

 

11

 

Amounts reclassified from accumulated other comprehensive income (loss) into earnings

 

 

11

 

 

11

 

Balance at September 30, 2018

 

  $

(627)

 

  $

10

 

  $

4

 

  $

(613)

 

 

 

 

For the Nine Months Ended September 30, 2017

 

 

 

Foreign currency
translation
adjustments

 

Unrealized gain
(loss) on forward
contracts

 

Unrealized gain
(loss) on available-
for-sale securities

 

Total

 

Balance at December 31, 2016

 

  $

(659)

 

  $

29

 

  $

1

 

  $

(629)

 

Other comprehensive income (loss) before reclassifications

 

20

 

(38)

 

(2)

 

(20)

 

Amounts reclassified from accumulated other comprehensive income (loss) into earnings

 

16

 

(7)

 

(2)

 

7

 

Balance at September 30, 2017

 

  $

(623)

 

  $

(16)

 

  $

(3)

 

  $

(642)

 

 

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Income taxes were not previously provided for foreign currency translation items, as these were considered indefinite investments in non-U.S. subsidiaries. Due to the Tax Cuts and Jobs Act enacted on December 22, 2017 (the “U.S. Tax Reform Act”), we re-evaluated our indefinite reinvestment assertions and no longer consider these items to be indefinite investments. The corresponding tax impact for this change in assertion was not material.

 

12.                               Operating Segments and Geographic Region

 

Currently, we have three reportable segments. Our operating segments are consistent with the manner in which our operations are reviewed and managed by our Chief Executive Officer, who is our chief operating decision maker (“CODM”). The CODM reviews segment performance exclusive of: the impact of the change in deferred revenues and related cost of revenues with respect to certain of our online-enabled games; share-based compensation expense; amortization of intangible assets as a result of purchase price accounting; fees and other expenses (including legal fees, expenses, and accruals) related to acquisitions, associated integration activities, and financings; certain restructuring costs; and certain other non-cash charges. The CODM does not review any information regarding total assets on an operating segment basis, and accordingly, no disclosure is made with respect thereto.

 

Our operating segments are also consistent with our internal organizational structure, the way we assess operating performance and allocate resources, and the availability of separate financial information. We do not aggregate operating segments.

 

Information on reportable segment net revenues and operating income for the three months ended September 30, 2018 and 2017, are presented below (amounts in millions):

 

 

 

Three Months Ended September 30, 2018

 

 

 

Activision

 

Blizzard

 

King

 

Total

 

Segment Net Revenues

 

 

 

 

 

 

 

 

 

Net revenues from external customers

 

  $

397

 

  $

627

 

  $

506

 

  $

1,530

 

Intersegment net revenues (1)

 

 

8

 

 

8

 

Segment net revenues

 

  $

397

 

  $

635

 

  $

506

 

  $

1,538

 

 

 

 

 

 

 

 

 

 

 

Segment operating income

 

  $

112

 

  $

189

 

  $

184

 

  $

485

 

 

 

 

 

 

 

Three Months Ended September 30, 2017

 

 

 

Activision

 

Blizzard

 

King

 

Total

 

Segment Net Revenues

 

 

 

 

 

 

 

 

 

Net revenues from external customers

 

  $

759

 

  $

531

 

  $

528

 

  $

1,818